LIBOR is the perfect example where so-called self-regulation, and blind faith in an unregulated, unchecked free market can be disasterous. They're building prosecutions on this as we speak.

Free markets are the engine of a progressive society, but simply assuming that they can regulate themselves or provide consumers any sort of protection through "choice," or the facade of choice in some markets... well, this is what you get.

This theme is hardly new news. But the extent of this scandal makes the issue crystal clear.

In order to work well, markets need a basic level of trust. As Alan Greenspan said, in 1999, “In virtually all transactions we rely on the word of those with whom we do business.” So what happens to a market in which the most fundamental assumptions turn out to be lies? That is the question in a scandal that has roiled the banking industry all summer. The LIBOR (London Inter-bank Offered Rate) index is the most important set of numbers in the global financial system. Used as a benchmark for interest rates around the world, it’s assembled by asking a panel of big banks to estimate what it would cost them to borrow money today, if they had to. Hundreds of trillions of dollars in derivatives, corporate loans, and mortgages are pegged to these rates. Yet we now know that for years LIBOR rates were rigged. Barclays has agreed to pay nearly half a billion dollars to regulators for its manipulations, and a host of other big banks are under investigation for similar misdeeds.

Rigging LIBOR was shockingly easy. The estimates aren’t audited. They’re not compared with market prices. And LIBOR is put together by a trade group, without any real supervision from government regulators. In other words, manipulating LIBOR didn’t require any complicated financial hoodoo. The banks just had to tell some simple lies.

They had plenty of reasons to do so. At Barclays, for instance, traders were making big bets on derivatives whose value depended on LIBOR; changing rates by even a tiny bit could be exceptionally lucrative. In the years leading up to the financial crisis, these manipulations were, in the words of the Commodity Futures Trading Commission, “common and pervasive.” And, once the crisis hit, banks had a new incentive to distort LIBOR: if their estimates were higher than their peers’ (meaning that it would be expensive for them to borrow money), investors, creditors, and regulators would worry that they were about to go under. So the banks sent LIBOR downward in order to make themselves look stronger than they were. The result was that, instead of reflecting what was real, LIBOR reflected what the banks wanted us to believe was real.

The most striking thing about this scandal is that it was predictable—the way LIBOR was designed practically invited corruption—yet no one did anything to stop it. That’s because, for decades, regulators and people in the financial industry assumed that banks’ desire to protect their reputations would keep them honest. If banks submitted false LIBOR estimates, the argument went, the market would inevitably find out, and people would stop trusting them, with dire consequences for their businesses. LIBOR was supposedly a great example of self-regulation, evidence that the market could look after itself better than regulators could.

But, if recent history has taught us anything, it’s that self-regulation doesn’t work in finance, and that worries about reputation are a weak deterrent to corporate malfeasance. To begin with, traders at a bank are typically rewarded according to how much money their trades make, not on whether they enhance the bank’s reputation. Bank C.E.O.s, meanwhile, are now paid so lavishly that even when they wreak havoc on a bank’s good name they can still walk away with immense amounts of money. What’s more, it’s not clear how good the market is at sniffing out and punishing bad behavior before serious damage is done. During the housing bubble, the stock prices of the banks that were making hundreds of billions of dollars in bad loans soared instead of falling. Once the crisis hit, the market did a great job of slamming the barn door. But it did nothing to stop the horses from escaping in the first place.

Even in the absence of market discipline, self-regulation could work if institutions had strong internal safeguards against corruption. But while every institution says that it has these norms—that’s why scandals like LIBOR are always blamed on a “few rogue traders”—the track record of the banking industry over the past two decades doesn’t inspire confidence in its devotion to the truth or to the public interest. The Barclays traders, for instance, sent e-mails casually thanking their colleagues for lying, and sometimes talked with their supervisors about their plans, revealing a culture in which deception was simply part of how things got done. As the behavioral economist Dan Ariely writes in his new book, “The Honest Truth About Dishonesty,” cheating is contagious—when we see others succeed by cheating, it makes us more likely to cheat as well. So when institutions tolerate, and even reward, bad behavior, all that self-regulation gets you is bankers gone wild.

How do we rein them in? We could start by making it harder for the banks to game the system—LIBOR, for instance, should be revamped so that it reflects actual market rates, not self-serving guesses. Then we need to admit that fraud is a crime and throw some people in jail. That shouldn’t be too hard in the case of LIBOR, which involves no complicated debates about who knew what when. Bankers were asked a simple question, and they lied in response. Most important, though, we need an attitudinal shift on the part of regulators, who need to recognize that their gentleman’s-club ethos is ill-suited to today’s financial world, and who need to be aggressive not just in punishing malfeasance but in preventing it from happening. (For some tips on how to do this, they might look to the way that American police forces have dramatically lowered big-city crime rates.) This new approach would be intrusive and overbearing, and would make it harder for bankers to do what they want. In other words, it’s exactly what the financial industry needs.

Obama's polices consist of forced "partnerships" with dozens of large banks along with General Motors and Chrysler. Italian fascism was one big bailout economy and one of the first things Hitler did was a giant stimulus. The state essentially is paying for the blunders of private enterprise and still is. This is fascism.

I continue to ask, in this era of everything being 'too big to fail,' why we don't talk more about flexing muscle in the realm of monopoly. Seems to me if something is too big to fail, it is likewise too interconnected, whether vertically or horizontally, to pass muster under existing law.
Sorry it doesn't serve as electoral catnip to the 'rich versus working class' warriors out there.

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If you become a technician, you just whup 'em on pure technique. /W.Shields

I continue to ask, in this era of everything being 'too big to fail,' why we don't talk more about flexing muscle in the realm of monopoly. Seems to me if something is too big to fail, it is likewise too interconnected, whether vertically or horizontally, to pass muster under existing law.
Sorry it doesn't serve as electoral catnip to the 'rich versus working class' warriors out there.

Because no bank individually has a monopoly. If one were to disappear, it wouldn't be an issue. The problem is that the financials are so large and concentrated that if one goes down the rest are shortly behind because they've been doing the exact same thing.

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The diameter of your knowledge is the circumference of your actions. Ras Kass

Former Citigroup Chairman & CEO Sanford I. Weill, the man who invented the financial supermarket, called for the breakup of big banks in an interview on CNBC Wednesday.

“What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail,” Weill told CNBC’s “Squawk Box.”

He added: “If they want to hedge what they’re doing with their investments, let them do it in a way that’s going to be mark-to-market so they’re never going to be hit.”

He essentially called for the return of the Glass–Steagall Act, which imposed banking reforms that split banks from other financial institutions such as insurance companies.

“I’m suggesting that they be broken up so that the taxpayer will never be at risk, the depositors won’t be at risk, the leverage of the banks will be something reasonable, and the investment banks can do trading, they’re not subject to a Volker rule, they can make some mistakes, but they’ll have everything that clears with each other every single night so they can be mark-to-market,” Weill said.

He said banks should be split off entirely from investment banks, and they should operate with a leverage ratio of 12 times to 15 times of what they have on their balance sheets. Banks should also be completely transparent, Weill said, with everything on balance sheet. “There should be no such thing as off balance sheet,” he said.

If banks hedge in any way, Weill added, positions should be mark-to-market and cleared through an exchange.

Weill said that by breaking up banks, they would be “much” more profitable.

"This is what all the regional banks do and everybody says buy regional banks,” he said. “They'll just be bigger regional banks.”

Weill suggested that breaking up banks is the only way to rebuild the financial industry’s reputation in the wake of recent scandals and missteps.

“I want to see us be a leader, and what we’re doing now is not going to make us a leader,” he said.

U.S. authorities are pushing for a settlement of interest-rate-rigging allegations with Royal Bank of Scotland Group that would result in a unit of the big British bank pleading guilty to criminal charges in addition to paying a penalty.

Once again the question raises itself: what is the point of filing criminal charges against a bank — not a bank’s executives or employees, but the bank itself? The WSJ today says that the US wants RBS to plead guilty to such charges, in addition to paying the inevitable fine over Libor fixing. But only, it seems, insofar as such an admission wouldn’t have any visible practical consequences:

Quote:

As part of UBS’s settlement last month, the Swiss bank’s Japanese unit pleaded guilty to wire fraud, a felony. Justice Department officials were heartened by the lack of a negative reaction in the markets and among regulators around the world to UBS’s guilty plea. Before the settlement deal, some officials had worried it could destabilize the bank. That has emboldened officials to pursue similar actions against banks like RBS.

Does “banks like RBS”, here, mean all of the banks which are going to settle Libor-rigging charges in the future? If so, it almost certainly includes US banks. And that in turn means that shareholders in such banks should be worried about potentially owning stock in a self-admitted criminal enterprise. On the other hand, maybe shareholders care only about the share price, and can take solace in the fact that Justice only seems to want to file criminal charges insofar as there’s a “lack of a negative reaction in the markets”.

The spectre everybody’s afraid of here is that of Arthur Andersen, which was prosecuted for obstruction of justice in the wake of the Enron scandal, went out of business as a result, and only later saw its conviction overturned by the Supreme Court. By that point it was too late: 25,000 jobs had been lost, and the accounting industry had become even more consolidated than it was before.

As a result, Justice seems to be treading very carefully here, prosecuting UBS — and, now, probably RBS as well — only with respect to activities in far-flung Asian outposts that no one cares much about. Think of it as the diametric opposite of the way that prosecutors went after Aaron Swartz: the US in this case is being minimally rather than maximally aggressive.

The problem is that this m.o. seems to violate a basic principle of justice — the principle that where there is a crime, there should be a punishment. Put the fines to one side: they will happen anyway, whether the bank admits to criminal activity or not. The criminal prosecution, in these cases, seems to be little more than a CYA move on the part of the administration, which can now have a slightly straighter face when saying that it’s being tough on the banks.

Still, maybe the markets should be more worried about such admissions than they’ve shown themselves to be until now. If a bank with a substantial US retail operation — JPMorgan Chase, say — admits to criminal misconduct, that doesn’t just open itself up to lawsuits from people who bought instruments linked to Libor, but also hands a whole new ammunition clip over to the opponents of big banks generally. Remember that most of the Dodd-Frank law still has yet to be written, including the details of the Volcker Rule; the worse the light the big banks are seen in, the tougher that regulators are going to allow themselves to get.

And then there’s the question of local prosecutors and regulators. The Justice Department might be very solicitous here, but that doesn’t mean that aggressive state attorneys general will follow suit. Once a bank has admitted criminal wrongdoing, its banking license in New York or any other state could surely be in jeopardy. And once a bank loses its banking license in New York, it’s basically dead in the water.

Justice, then, needs to ask itself what exactly it’s trying to achieve with these criminal admissions. In principle, I’m all in favor of holding criminal organizations to account for their actions. But only if doing so does more good than harm.